Saving with the TFSA? Contribute With Caution

When the Government of Canada introduced the Tax Free Savings Account (TFSA) in 2009, the response was positive. Although contributions to a TFSA are not deductible for income tax purposes, the income generated in the account – such as interest and capital gains – is generally tax-free. True to its name, the TFSA is a vehicle that lets you invest your money tax-free during your lifetime. As well, the notion that the TFSA can operate like a “savings account” can be appealing, as it appears to offer the flexibility of making contributions and withdrawals.

Unfortunately, appearances can be deceptive. While the TFSA is a tax-saving vehicle, one must exercise diligent care where there is a series of withdrawals and contributions. A penalty on excessive contributions applies if an “excess TFSA amount” existed at any time in a month, and equals 1% of such amount in that month. The 1% tax continues to apply for each month that the excess amount remains in the TFSA.

Consider John’s situation. He contributed $5,500 (the annual limit) to his TFSA in January 2013, withdrew $4,000 in mid-March, and re-contributed $4,000 in late March. Meanwhile, his wife Molly also contributed $5,500 in January, and contributed another $4,000 in mid-March and withdrew $4,000 in late March. John was convinced that he was compliant, and suspected that his wife had gone offside by over-contributing. In June 2014, John and Molly received their 2013 assessment notices with two surprises:

  1. Both were assessed penalties;
  2. Molly’s penalty was only $40, but John’s was $400!

The common misconception lies in the confusing definition of “excess TFSA amount”. In simple terms, it equals total contributions minus the $5,500 limit. Total contributions include amounts contributed at any time during the year – even after first withdrawing an amount. However, only withdrawals made after contributing more than the $5,500 limit reduces the excess amount. This is why Molly’s entire $4,000 withdrawal qualified, while none of John’s did. Therefore, John ended up with an excess TFSA amount of $4,000 for 10 months, resulting in a $400 penalty ($4,000 x 1% x 10 months), while Molly’s was only $40 ($4,000 x 1% x 1 month). The logic employed here may seem counter-intuitive, but taxation is rarely designed for clarity.

For any year in which tax is payable on an excess TFSA amount, you must complete and file Form RC243 “Tax-Free Savings Account (TFSA) Return”, along with accompanying schedules. Under proposed changes, a TFSA return must be completed and filed by June 30 of the year following the calendar year in which the over-contribution happened. If the return is filed after the due date, a late-filing penalty will be charged.

Amidst the confusion surrounding the TFSA rules, the government’s message is clear in at least one area: Contribute, but with caution. For this reason, individuals are encouraged to consult their tax advisors on their TFSA matters.

In Summary:

  • TFSA is a great way for Canadian residents to invest money tax-free.
  • As of January 1, 2013, you can contribute up to $5,500 annually to a TFSA.
  • Unused TFSA contribution room is carried forward and accumulates in future years.
  • Withdrawals from a TFSA are tax-free.
  • Full amount of withdrawals can be put back into the TFSA in future years.
  • Re-contributing in the same year may result in an over-contribution amount and a penalty tax.


Charles Fu is the Senior Tax Manager at Sloan Partners. Contact Charles today for an analysis of your family’s tax savings opportunities.

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